LLP vs LLC: 4 Differences Between Two Legal Business Structures
- State Laws
- Tax Benefits
- Liability Protection
- Management Structure
Before going through the advantages and disadvantages of these two types of business formation, it would be helpful to define what they are. The unifying term between both acronyms is limited liability. When a person or partnership operates a business without separating themselves from the business, they essentially put themselves in a situation of unlimited liability.
If anything goes wrong (malpractice, monetary loss caused to a client, charges of discrimination from employees) the business owner’s personal assets could be targeted in a lawsuit to award damages to the Plaintiff. But by creating a limited liability partnership or corporation, the business owners protect themselves from the threat of lawsuits, debts, and other damages.
Most anyone running a business will want to create a legal structure that reduces their own liability by separating themselves and their personal assets from that of the business and its activities. An LLC, or Limited Liability Company, will allow a business to avoid double taxation that comes from having profits subjected to a corporate tax and then a personal tax, while also avoiding the cumbersome red tape required of a corporation. Corporations have shareholder requirements, establishing a board of directors, and director meetings.
A Limited Liability Partnership is a similar pass-through entity, but it must (as the name implies) have at least two partners—unlike an LLC, which could be composed of just one person. However, in most states both an LLC and an LLP can have an unlimited number of partners. In the case of the LLP, these partners will tend to be operating with a professional license of some sort and will share a greater degree of responsibility in the business.
Both an LLC and LLP are ways for a business owner to create a separate legal identity, mostly for their personal liability protection. There are other ways to structure a business, such as a non-profit organization with tax-exempt status, or a corporation that will have to pay taxes. Selecting the right type of business entity and drafting articles of incorporation will depend on a number of factors such as location, operations, the business, and the amount of projected business revenue.
But for many practitioners and business owners, an LLC or LLP will be the best option for the size of their business, allowing them to create a separate legal structure without the complexity called for by a corporation.
LLP vs LLC: 4 Differences Between Two Legal Business Structures
In most cases, an LLC can be formed by any individual, group of persons, or business. The ability to file an LLP—in some states—is restricted to certain professions that require a license to practice, such as being an attorney, doctor, accountant, or engineer. And in some states, such as Nevada and California, licensed professionals must form an LLP should they wish to structure their business in a way that avoids incorporation but still limits their personal liability.
For this very reason, some firms that would be practicing business across state lines will opt to form an LLP, so they can conduct business in as many states as possible—especially in states that allow professional firms to operate as an LLP, but not an LLC. If you are wondering about the laws in your state, it’s best to check with your state’s secretary of state office. That office will also be able to answer any questions about LLP registration or obligations specific to that state.
Both an LLP and an LLC are a pass-through entity or disregarded entity, meaning that business profits or losses will be reported on Schedule C of each and every partner’s personal Form 1040, which is used to file personal income tax. By contrast, a corporation pays taxes on its earnings as a separate entity (at the time of this article, a flat rate of 21%), while owners are paid a salary from company payroll—and if, after expenses, they are awarded additional company profit, that money will be reported on their personal tax return.
If an LLC is operated by an individual, that business is considered a sole proprietorship, the earnings will pass through to that individual’s personal tax return, and they will pay self-employment tax. In some cases, an LLC may opt or be required to be taxed like a corporation, but an LLP will almost always be treated as a disregarded entity: earnings will pass through to be reported on the personal tax return of each partner.
In this way, an LLC offers a little bit more flexibility than an LLP in terms of taxes, even though both are most often subject to pass-through taxation. Small business owners or members of limited partnerships will file self-employment income on their tax returns.
When forming a business, LLP or LLC members may enter the business in a general partnership or limited partnerships. General partners tend to have equal say in running the business and share liability. A limited partner may contribute capital but have less say and less liability than the general partners who manage the business. Partnership law is very complex and varies by state, as does the implications of its tax treatment, so it’s best to get qualified legal assistance to explore the nuances of what might be best for your business and your own liability.
If there is more than one partner to an LLC, each partner is legally protected from the liability of the LLC itself. For example, a business creditor cannot sue a member to reclaim a debt that burdens the business. However, if one member commits a legally actionable act, everyone in the LLC can be held accountable.
By contrast, partners in an LLP are only responsible for their own negligence or malpractice, and no one is responsible—at least legally—for anyone else’s mistakes. In some states, partners of an LLP can be responsible for debts of the partnership, so it’s important to see what laws apply in your state.
In general, however, an LLP provides a little more legal protection for the individual partners. As mentioned, this legal protection is mainly asset protection from lawsuits or collections of business debts.
The two most common ways for the management of an LLC to be structured are member management and manager management. With member management, the sole proprietor or a partner of the LLC manages the business themselves, while with manager management, they appoint someone else (a manager) to manage the business—and this manager does not have to be a partner of the LLC. The exact terms of management, if an LLC has multiple members, should be spelled out in an LLC Operating Agreement.
An LLP requires a little more participation from the partners. These partners will have equal shares in running the business, and an equal share of the profits—though the exact nature of responsibilities will need to be spelled out, and modifications to profit sharing may be made in a Partnership Agreement. Moreover, an LLP gives each partner a little more power than the members of an LLC might have, as partners in an LLP all have an equally binding power when it comes to company contracts. However, if one partner in the LLP is elected as a managing partner, they will take on more liability and the other, sometimes silent, partners will have increased liability protection. This situation is sometimes called a Limited Liability Limited Partnership (LLLP) but not all states recognize this particular legal entity.
In this regard, an LLC offers a little more flexibility in terms of management structure. This is why many businesses that do not operate in the context of performing activities that require professional licensure will opt for an LLC: The owner or owners can hire a manager or managing team to take care of daily affairs, while they pursue other business activities or oversee other parts of the business. Examples of these types of businesses might include retail operations, restaurants, and venues for entertainment.
Should I Form an LLC or LLP?
If your business really will operate along the lines of a partnership, where each member is engaged in a specific task that may or may not be the same, but either way contributes to the overall functioning of the business, then LLP is probably your best bet. This would include many professional practices such as architects, doctors, lawyers, and accountants. An LLP is even more desirable if your business will be conducted across state lines since in some states licensed professionals are required to operate under an LLP, and not an LLC.
However, if your business will require a little more flexibility in terms of management structure and profit-sharing, an LLC will likely suit you better. With an LLC, you will gain in terms of tax-based flexibility and be able to hire outside management without making those individuals owners or partners in the business. For example, an LLC for real estate investing will protect an investor from liabilities engendered by their assets or business activity like rehabbing homes. They will also be able to hire outside managers such as general contractors without needing to make them business partners or take on the burden of being liable for the actions of these managers.
If you do have business partners in your LLC, you will be more exposed in terms of liability to their negligence or malpractice. Of course, it almost goes without saying that if you operate your business as an individual, you will not be able to form an LLP anyway, because an LLP requires at least two partners.
Exploring the various options for the legal structure of your business is an important first step, and consulting with a licensed professional is a good idea when you have questions about your specific situation.
LLP vs LLC: What’s the Difference?
Either way, forming an LLC or LLP is crucial for separating you and your personal assets from that of the business in which you’re involved. LLCs do seem to offer more flexibility in terms of taxation and management structure, but there is less legal protection against the actions of the partners. Moreover, laws do vary by state, so the exact legal climate of your location will play a big part in informing you whether you should structure your business as an LLC or LLP. To that end, you will want to obtain some qualified legal counsel to help you pick the right way to limit your liability.
The smart business owner will want to remove themselves from the risky state of unlimited liability by creating a separate legal entity for their business. They’ll want one that separates the owner and their assets from the activities, assets, debts, and obligations of the business. But the ins and outs of which model to pick (LLC or LLP) will depend on several factors that should be considered with the assistance of some competent legal counsel and a discussion of how the business will operate in the future.
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